Why Invest in Negative Interest Rates

December 9, 2008 1:08 PM

Hey Financial People: The interest rate on 3 month Treasury Bills just went to -0.01%. Why would anybody, or any institution, buy them?

Why not just hold on to your capital as cash? Or does a negative interest rate not mean what I think it means?

posted by jsonic to work & money (10 comments total)

Because they're scared their bank will fail....
posted by bananafish at 1:18 PM on December 9, 2008

They feel their money is safer kept in T-bills than in banks (or keeping several million dollars in cash locked up in a warehouse somewhere).

Another note: The interest rate isn't negative, the yield's negative. The higher the purchasing price of the bond, the lower the yield (e.g. paying $105 for a bond that will pay you back $100 in 3mo. from now, as opposed to paying $95 for the same bond). The high prices for government bonds are due to high demand - in other words, people are willing to pay the government a premium to hold their money for them.
posted by pravit at 1:23 PM on December 9, 2008

Why not just hold on to your capital as cash?

As cash where? In a bank? Bank accounts are less safe than t-bills, because as bananafish said, banks can fail.

In a big building with armed guards standing around it? That would cost money too.

When you buy t-bills, you're always "paying" for the safety in the form of lower rates than riskier investments. In this case, the premium has gotten high enough and the rates for competing investments have gotten low enough that it just barely reaches the point where the t-bill investor has a net loss.
posted by burnmp3s at 1:25 PM on December 9, 2008 [1 favorite]

It's an interesting question not so easily answered as the above posters make it out to be. The Aleph Blog had an interesting post in October about other instruments that have the "full faith and credit" guarantee of the US Government and yet trade at a spread to Treasuries.

When off-the-run Treasuries trade at a premium to on-the-run Treasuries, it probably means that creditworthiness is less of an issue than is liquidity. On-the-run (as in, just issued) US Treasuries are probably the most liquid asset in the world.
posted by mullacc at 1:38 PM on December 9, 2008 [1 favorite]

Because you could buy them at a discount on the assumption that they'll go back up again and make a tidy profit. It's a lot like bonds, which normally don't lose their value unless there's a threat of default, in which case they trade for less than their face value.
posted by hylaride at 1:56 PM on December 9, 2008

When off-the-run Treasuries trade at a premium to on-the-run Treasuries

Er, I meant a "discount", not a premium, of course.
posted by mullacc at 2:00 PM on December 9, 2008

Check out the planet money podcast...they talked about this a while ago. Basically because they have to put their money somewhere . And since the places they can invest it seem really dangerous right now, putting it in something really secure is their best bet. It's an indicator for the economy, in this case indicating that things are totally screwed.
posted by sully75 at 3:44 PM on December 9, 2008

Because you could buy them at a discount on the assumption that they'll go back up again and make a tidy profit. It's a lot like bonds, which normally don't lose their value unless there's a threat of default, in which case they trade for less than their face value.

Actually, the exact opposite is happening here. If interest rates go up the value of these bonds will drop. The price of these bonds has already risen to artificially high levels due to their security and liquidity. See pravit's comment.
posted by caddis at 7:15 PM on December 9, 2008

When money market accounts threaten to reduce the per-share price to 95 cents, this kind of stuff starts to make sense, in a world where nothing financial seems to make sense any more.
posted by yclipse at 7:55 PM on December 9, 2008

Because investors expect deflation.

Just as inflation erodes purchasing power, deflation^ increases purchasing power. But conversely, it means sellers receive less money for their products and services. That can lead to job losses and business closures. For consumers, it can increase the relative burden of debt such as mortgages. That fixed note coming out of your fixed wages now represents an opportunity cost. This can increase defaults and foreclosures, which is where the risk of bank failures comes in.

Essentially, in exaggerated form, hyperinflation of the wheelbarrow-full-of-money type means that there is no reason to save money at all. Money in the bank is losing value, because no bank can pay you interest at the rate that your money's purchasing power declines. So nobody saves.

Conversely, in a deflationary economy, everybody saves. This decreases the power to "purchase" interest rates from a bank by lending them your money. Money is in oversupply (I know, it sounds like something good), so demand craters. The ability of banks to provide liquidity in the form of credit evaporates. In this environment, receiving a negative interest rate can be a form of earning purchasing power in relation to metrics such as the CPI.

Essentially you are giving up a portion of the paper value of your money in return for the guarantee that you'll have it later on, even if there is an oversupply and nobody "wants" your money. Put another way, at maturity, your money's purchasing power has presumably increased more than you lost by paying negative interest.

Now, getting back to that bank thing. Certainly we have regulatory structure in place that except in rare cases like Indymac tend to prevent bank runs. (Really, we are so terrified of them that we make sure that no bank is ever run on -- it gets merged with a stronger bank.) But at a macro level, this economy is experiencing the equivalent of a country-wide bank run. (Actually, it's the first thing in my lifetime that truly resembles a full-scale financial panic, such as used to be scarily common in the century before last.) Whether through pay-downs or write-offs, banks across the country are experiencing enormous losses of capital. It's not certain that the Paulson bailout is going to stabilize things more than temporarily, given the likelihood of other shoes dropping such as consumer debt (credit card default) crisis.

Stability and certainty has never seemed more desirable. That's what you get, in theory, with T-Bills.

Anyway, what yclipse said. There's going to be a lot of not making sense in the next year.
posted by dhartung at 11:36 PM on December 9, 2008